Bond Vigilantes Vs Operation Twist

Macro Perspectives: Fri 19 Mar 2021

After the Fed meeting, where Jay Powell once again painted an impractical economic outlook, (where inflation remains ultra-tame in the face of pent-up demand, supply shortages and a firestorm of global liquidity) I ended my morning note yesterday saying, "I suspect the bond vigilantes will go to work, selling Treasuries, pushing market interest rates higher."

Check. Rates ripped higher - this is the bond market forcing the hand of the Fed.

How will the Fed respond? Will they begin to acknowledge the inflationary threats and begin telegraphing a change of direction in monetary policy? Or will they take control of the longer term interest rate market (through Operation Twist)?

No way, on the former, very likely on the latter.

Until they do, the bond vigilantes should continue to press the situation, driving rates higher and higher. This will not be a good “risk environment” - thus, we’ve already seen heavy selling across stocks and commodities.

The S&P futures put in a technical reversal signal today, an "outside day." We may see more of this until the Fed is forced to respond, by putting a cap on longer term interest rates.

As we've discussed, they can do this by selling short term Treasuries and using the proceeds to buy longer term Treasuries (Operation Twist). This would restore the market risk appetite, but only until inflation begins to rear its head.